What is an Annual Percentage Rate?

What is an Annual Percentage Rate?

Posted on April 26, 2012 by Jennifer in APR

When you review or compare credit card offers, one of the most important features you probably look at is the card’s annual percentage rate, or APR. But do you know what an APR really represents or how it can affect you as a cardholder?

Let’s explore some of the basics of credit card annual percentage rates.

What a Credit Card APR Is

Your APR is what we often refer to as your interest rate. More specifically, it’s the amount of interest you would be charged on a balance over the course of a year.

Types of APRs You Might Find Advertised

When we think of interest rates, we often automatically think about the interest we’ll pay on new charges. But there are actually several different kinds of APRs that can be tied to a single credit card account, each applying to a different type of transaction. For example, you might find the following APRs on a credit card offer.

  • Purchase Rate — The annual percentage rate for new purchases
  • Balance Transfer Rate — The annual percentage rate for balances transferred to the card from another account
  • Cash Advance Rate — The APR for ATM cash withdrawals or other cash-equivalent transactions using your credit card

How Your APR Affects Your Monthly Interest Charges

When you see an APR advertised (of any kind), how does that impact the interest charges that show up on your monthly credit card statement? It’s not as simple as multiplying that percentage rate by your existing balance. Your interest charges are actually much lower than that on a month-to-month basis, which is why it pays to eliminate your balances as quickly as possible, before those charges add up.

In other words, if you have a 20% interest rate and a $500 credit card balance, that doesn’t mean you’ll pay $100 in interest on your next statement. That’s how much it would cost you over the course of a year. But ideally, you’ll pay off that balance long before a year goes by.

There are different ways of calculating monthly interest charges. For example, let’s say you’re charged based on a monthly periodic rate. In that case you would divide your APR by 12 months in the year. For a 20% APR, that comes to around 1.7%. That means your monthly interest charge for that $500 balance would be $8.50. Of course that’s over-simplifying things a bit. You also need to account for introductory rates that change within a year and grace periods (periods where you aren’t charged interest).

Do you know how your interest charges are calculated? When you do, it makes it easier to verify your charges when you get your monthly statements. And that’s a great reason to learn about your APR — to make sure you’re never overcharged.